How Much Has It Earned? – Beware The Pitfalls When Comparing Investment Returns.

We have all been taught to look at the percentage rate of return when comparing investments.

However, in many situations it is important to look deeper than just the annual percentage return.

This is especially so in the case of retirement.

Let me explain with an example. Let’s say you start with $1,000, and it earns 10%, and you take $50 for living expenses – result is an account value of $1,050. If it then drops 10%, then you’re back to $945. Take away $50 for living, and you’re back to $895. If it then grows by 10%, then the account balance after living expenses is $934.50. Another year of 10 % returns gives us $977.95.

Let’s look further. The average return over the period is (10%-10%+10%+10%) divided by 4, gives an annual average return of 5%.

Aha, something is awry. The amount being taken out each year is only 5% of the original balance, the average return is 5%, yet the balance has gone backwards. How come?

Well, in year 2, the $50 withdrawn was from a reduced account value, and amounted to 5.3% of that amount.

The moral of the story is that it is important to look beyond just the rate of return. There needs to be a new approach to planning retirement income.

With this in mind, I commissioned research to track retirees’ account balances over a number of scenarios, since 1969. The results are revealing.

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